Leaving a Legacy? What Are the Tax Implications? – August 2013

The Shaw Atlas

August 2013

Welcome to The Shaw Atlas, the monthly newsletter from Shaw & Associates, CPAs & Financial Advisors. We look forward to keeping you abreast of ever-changing tax codes, providing you with money saving accounting tips and illustrating proactive strategies to help you achieve the financial life you envision.

“Everyone must leave something behind when he dies . . . Something your hand touched some way so your soul has somewhere to go when you die . . . It doesn’t matter what you do, so long as you change something from the way it was before you touched it into something that’s like you after you take your hands away.”

– Ray Bradbury

Leaving a Legacy? What are the Tax Implications?

Kevin Shaw, CPA

During your lifetime, or upon your death, there are many ways to leave a legacy to whomever you choose. Children, grandchildren, friends, distant relatives and/or your favorite charitable organizations can all be beneficiaries of your desire to give away your accumulated personal wealth. The question becomes: what are the tax implications of leaving this legacy and how do I minimize these taxes?

Transfer of assets upon death

When you die, your net assets, after paying all of your outstanding debts, become your estate and will be distributed to heirs based upon various legal documents (wills, trusts, life insurance policies, etc.), or by virtue of state laws. To prevent the state from deciding how to distribute your net assets, it is important that you create a will and/or a trust that dictates your wishes. Depending on the size of the estate, some of the transfer of these assets could be taxable at a rate of 40%. As you can see this could be very costly without proper planning.

The intricacies of estate planning are very complex and beyond the scope of this article. What is important to know is that every person has an estate exemption. Taxation of an estate does not occur until assets exceed this exemption amount, and only on the amounts above the exemption. Over the last 15 years, this exemption has been as low as $600,000 to its current high of $5,250,000. You may ask yourself why you should be concerned if your estate is less than this amount. Because of changing state laws and the continuing fluctuation of the federal exemption amount, it is important that you continue to update your estate plan to encompass any of these or future changes.

You can leave an unlimited amount of your estate to your spouse without paying any estate taxes. For any other heirs, the current exemption of $5,250,000 applies. If the value of your net estate (which includes life insurance) exceeds this amount, it is very important that you talk to an estate planner, even if you intend to pass the entire amount to your spouse. Since both spouses have an estate exemption (total in 2013 of $10,500,000), improper estate planning can lead to the loss of one of these exemptions, thereby exposing a significant portion of the estate to taxes that could have been avoided.

Transfer of assets during your lifetime

Many people would like to start gifting part of their estate during their lifetime but are afraid of the gift tax laws. You may have heard that you are allowed to give any person a gift up to a certain amount each year ($14,000 in 2013) without having to worry about gift taxes. However, gifting can be virtually tax-free, up to a certain amount, with a little proper planning. Here are a few tips:

First, it is important to understand that the person receiving the gift does not pay any tax and is not responsible for filing a gift tax return. All the responsibilities of paying any gift taxes resides with the person giving the gift.

The $14,000 annual exclusion is between two specific people. Thus, in a family situation, this can be multiplied quite a bit. Let’s assume a husband and wife wish to transfer cash to a married child that also has two children. The husband could transfer $14,000 each to the child, the child’s spouse, and to the two grandchildren. The wife could do the same. Thus, the husband and wife could transfer a total of $112,000 in a given year without having to pay any gift tax.

Certain gifts are not subject to gift tax:

Gifts for tuition or medical expenses are not subject to gift taxes. Due to some restrictions on how you gift tuition and/or medical costs, it is important that you talk to your tax advisor before making these gifts.

Gifts to spouses are also unlimited.

Gifts to a political organization for its use.

Gifts to recognized charitable organizations.

Sometimes, a person wants to make a large gift that would not be completely excluded under the rules discussed above. You can still make that gift without incurring any gift tax. Many people do not know that you can use your estate exemption ($5,250,000 in 2013) during your lifetime. To do this you have to file a gift tax return with the IRS indicating that you have used a portion of your estate exemption. The IRS will then know that upon your death, your estate exemption will be reduced by the amount you used during your lifetime. As you can see, gifting would be completely tax-free for anyone who has an estate valued at less than the exemption amount. However, there are several other factors that one must consider before deciding to use up part of their exemption. For instance, when assets transfer at death, the heir gets a step-up in basis on these assets. This step-up does not happen when gifting. The step-up could be very important, depending on the gifts, so please consult your tax advisor before starting a gifting program.

As you can see, there are many moving parts to the estate and gift tax rules and regulations. Thus, it is very important to do proper planning so that you can minimize your taxes and make sure that your assets are transferred to those that you want to have them. For more information, or to arrange for a consultation, please contact Cassy to make an appointment.

Everyone wants to be remembered, and your legacy is what you leave behind for future generations. Since August is National “What Will Be Your Legacy? Month, we would like to give you 4 simple ways you can create a legacy for your family.

Provide a family history

Give to charity

Write a legacy letter (a letter that shares what has been most important in your life and to be shared with loved ones while you are still alive).

Prepare an ethical will (a document designed to pass ethical values from one generation to the next).

As part of our continuing efforts to support local non-profits, we at Shaw & Associates enjoyed a company volunteer day at The Family Center/ La Familia. The Family Center is an early childhood center for local families from all walks of life. They provide families with childcare, education and parent enrichment programs. We were very impressed by their operation and enjoyed helping them with projects around the center. We look forward to our next volunteer project next year.